Dynamite the Nobel prize in economics

October 9th, 2009

Christopher Swann, Reuters

Did you know that worms cause cancer? They don’t, of course, yet in 1926 Johannes Fibiger won a Nobel Prize in medicine for this “discovery.”

The Nobel committees for science prizes rarely make such amusing blunders, but those awarding the medal for economics have a long history of endorsing ideas that are useless, incorrect and even dangerous.

With the latest winner of the $1.4 million windfall due to be named on Monday, the case is stronger than ever for scrapping the prize altogether. The economics award — created in 1968 by Sweden’s central bank — has always been the odd man out.

Far from celebrating those who have “conferred the greatest benefit on mankind” as Alfred Nobel intended, the economics prize has done more harm than good.

The prize has fostered a faith in economists that is often misplaced. Friedrich Hayek, who won in 1974, said he would have advised against creating the award. The title, he said, “confers on an individual an authority which in economics no man ought to possess.”

Laureates, he suggested, should be required to take “an oath of humility … never to exceed in public pronouncements the limits of their competence.”

Sadly, economists, as a caste, have showed no such humility. The Nobel imprimatur has encouraged us to exaggerate the scientific quality of the dismal science.

Unlike their counterparts in physics, chemistry and medicine, economists have precious little predictive power. Lately, there has been much soul searching about the failure of economists to anticipate the 2008 meltdown. But given the profession’s history it would have been surprising if they had.

Over the past 20 years economists have failed to forecast any of the major twists and turns of the U.S. economy. Economists, as labor leader George Meany once grumbled, is “the only profession where a person could be considered an expert without having once been right.”

Worse still, the Nobel committee has set its seal on ideas that have been extremely toxic. Nobel Prize-winning theories were behind the biggest market meltdowns since the Great Depression.

In 1987, wide acceptance of the Black-Scholes-Merton option pricing model helped turn a market stumble into the worst one-day fall in Wall Street history, threatening the entire system. The model was rejected by traders, yet a decade later Robert Merton and Myron Scholes picked up their check from the Riksbank.

Or take Value at Risk models — backed by the Nobel Prize-winning portfolio theories of Harry Markowitz — which was culpable in both the panics of 1998 and 2008. These models helped justify skimpy capital ratios in the run-up to 2008.

“These theories have managed to transform tranquillity into turbulence, creating crises out of nowhere,” says Pablo Triana, author of “Lecturing Birds on Flying: Can Mathematical Theories Destroy the Financial Markets?” He adds: “The Nobel Prize helped give them respectability.”

And Nobel-endorsed economic theories helped justify the aversion to regulation showed by policy makers like Alan Greenspan. A long list of laureates from the Chicago school from Gary Becker to Edward Prescott helped promote the idea that governments should stand aside.

If the Swedish central bank wants to give away 10 million kronor a year, that is their business. But the prize should not be allowed to coast on the prestigious Nobel brand. Surviving relatives of Nobel are right to ask that their name be taken off the prize.

Aside from a new name, the prize should also come with a label:

WARNING: These theories should not be used by everyone. Side effects can include: financial crises, turbulent stock markets and banking collapse.